5 Factors That Affect Your Credit Rating

The credit rating of an individual or corporation is a report which shows how capable a certain entity is of returning a prospective loan. A credit rating report is typically requested by banks, credit card companies, or other lenders, before they issue a loan, so that they can determine the risk of defaulting on that loan as well as the loan interest rate (the higher the risk of defaulting, the bigger the interest rate on the loan). Credit ratings are prepared by specially authorized credit reporting agencies, which take into consideration the following main factors:

1. An Individualís Credit Payment History

An individualís credit payment history is one of the top factors in credit rating assessment, accounting for about 35 percent of the total credit score. The payment history shows how capable an individual was of making due payments in the past. A history which indicates that payments have always been duly deposited will contribute to a highly positive credit rating and much better loan conditions. Even occasional late payments affect the payment history, though creditors are sometimes inclined to shut their eyes to single cases of late payment. Another factor that plays role in determining the credit score is how regularly a person pays his utility and other bills. Needless to say, defaulting on loans and bankruptcy has negative and long lasting effects on the credit score.

2. Credit Length

The length of the period for which an individual has enjoyed credit is also an important factor in credit rating estimation (it accounts for 15 percent of the total credit score). This metric is based on the following rationale: the longer the time credit has been enjoyed, the more challenges an individual will have overcome in satisfying credit requirements, i.e. the more reliable and credit-worthy this individual is. Regular payments on long-term loans prove to creditors that the borrower has stable sources of income and handles well cases of emergency.

3. Amount and Number of Current Loans

If the loan borrower has already taken and is currently encumbered with several other loans, their number and amount will affect the credit rating. In general, the larger the sums owed, the less favorable the credit rating will be.

4. Credit Applications

Many and/or recent credit applications affect an individualís credit rating negatively, as they indicate that this individual is in need of much money. This, in turn, suggests to prospective lenders that there is a higher risk of loan defaulting.

5. The Type of Credit an Individual Uses

There are two major types of credit (revolving and installment), which will have different weight on the credit rating.

Installment credits, for example, car loans or mortgages, are paid with predetermined contributions at regular time intervals. As a mortgage is harder to obtain, requiring greater credit worthiness, it will have a more positive influence on the final credit score than the other installment loans. Opponents of the credit score system and consumer advocates have warned about possible discriminatory effects of scoring. Minorities, low-income workers, and other segments of the population have limited access to installment credits and major credit cards. For this reason, they may score lower than the general population. At the extreme, some question the overall accuracy of credit report data.

Unlike the first type of credit, revolving credits (e.g. a credit card or a department store card) are not redeemed with a fixed number of payments and can be used even after they have been paid in full. Credit reporting agencies give higher ratings to individuals that use a blend of credits from both types, as this indicates greater flexibility in meeting different loan conditions.